The Effect of Founder-CEO Overconfidence on Merger Premium

Master's Thesis, 2014

85 Pages, Grade: 1,0






1.1. Aim of the Chapter
1.2. Background and Context to this Study
1.3. Rationale, Aims and Intended Contribution
1.4. Outline of the Dissertation

2.1. Aim of the Chapter
2.2. Merger Premium and M&A in the High-Tech Industry
2.2.1. Review of Merger Premium Determinants
2.2.2. Review of M&A in the High-Tech Industry
2.3. CEO Overconfidence
2.3.1. Concept of Overconfidence
2.3.2. Review of Overconfidence and Merger Premium
2.3.3. Review of Overconfidence Measures
2.4. Review of Founder-CEO Characteristics
2.5. Reflection on the Literature Review
2.6. Hypotheses Development

3.1. Aim of the Chapter
3.2. Variables Description
3.2.1. Dependent Variable
3.2.2. Overconfidence Measure
3.2.3. Control Variables
3.3. Data Sample
3.3.1. Sample Collection and Sources
3.3.2. Sample Description
3.3.3. Trend Developments
3.4. Research Method
3.4.1. Ordinary Least Square (OLS)
3.4.2. Dissertation Model
3.4.3. Time Fixed Effects

4.1. Aim of the Chapter
4.2. Correlation Matrix
4.3. OLS Regression Results
4.3.1. Impact of Founder-CEO Overconfidence on Merger Premium
4.3.2. Impact of Acquirer and Target CEO Overconfidence on Merger Premium
4.3.3. Founder-CEO Merger Decision-making - Differences between Merger
Premia paid by Founder-CEOs and Manager-CEOs
4.4. Robustness Checks
4.4.1. Corporate Governance and CEO Overconfidence
4.4.2. Media Portrayal as Measure of Overconfidence
4.4.3. Principle Component Analysis
4.5. Summary of Empirical Findings

5.1. Aim of the Chapter
5.2. Summary of the Study and general Conclusions
5.3. Contributions
5.4. Limitations and Direction for further Research



Figure 1-1 High-Tech Acquisitions

Figure 1-2 Global High-Tech M&A Volume - on a first half-year comparison

Figure 3-1 Number of Deals and Mean Deal Value - annually distributed

Figure 3-2 Mean Merger Premium - annually distributed

Figure 3-3 Method of Payment and Relatedness - annually distributed


Table 2-1 Literature Overview regarding CEO Overconfidence and Merger Premium

Table 2-2 Overconfidence Measures

Table 3-1 Summary of Dependent, Independent and Control Variables

Table 3-2 Data Collection Process

Table 3-3 Firm Financials and Deal Characteristics

Table 3-4 CEO Demographics

Table 4-1 Correlation Matrix

Table 4-2 Regression of Merger Premium and Founder-CEO Overconfidence

Table 4-3 Regression of Merger Premium and Acquirer and Target CEO Overconfidence combined

Table 4-4 Mean and Median Merger Premium

Table 4-5 Regression of Merger Premium and Founder as dummy Variable

Table 4-6 Corporate Governance Variables

Table 4-7 Regression of Merger Premium and CEO Overconfidence - Controlled for Cor- porate Governance

Table 4-8 Regression of Merger Premium and CEO Overconfidence - Measured with Media Portrayal Proxy

Table 4-9 Regression of Merger Premium and CEO Overconfidence - Principle Component Analysis

Table 4-10 Summary of Empirical Findings

Table A.1 Most Valuable Brands Fehler! Textmarke nicht definiert

Table A.2 List of Founder-CEOs

Table A.3 Firm Financial and Deal Characteristics: Founder & Manager Sample

Table A.4 Descriptive Statistics

Table A.5 Number of Deals and Mean Deal Value - annually distributed

Table A.6 Method of Payment, Relatedness and Mean Premium - annually distributed ..

Table A.7 Unit Root Test

Table A.8 Regression of Merger Premium and CEO Overconfidence - Founder-CEO and Manager-CEO Sample

Table A.9 Principle Component Analysis

Table A.10 Sample of OLS Regression without YFE

Table A.11 Sample of OLS Regression with YFE


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1.1. Aim of the Chapter

This chapter presents an introduction to the topic and provides an overview of the dissertation. As a starting point, the background of the current developments in mergers and acquisitions in the high-tech sector and developments in companies’ CEO policy are presented. This section also describes the topic of overconfidence. Afterwards, rationale, aims and intended contributions are presented. Finally, the last section outlines the basic structure of the research.

1.2. Background and Context to this Study

High-Tech Industry

In February 2014 Facebook announced the acquisition of WhatsApp for a total of $19 billion. This transaction marks the peak (up to now) of a series of recent mega hightech acquisitions. The following figure presents that ten recent acquisitions in the high-tech sector had deal values of and above one billion US dollar.

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Figure 1-1 High-Tech Acquisitions

Source: statistica (Richter 2014)

High-tech companies have emerged as an important factor in the economy through their technological advancements and their contribution to efficiency gains. The char- acteristics of the high-tech industry are a high innovation rate and short product life cycles. Thus, the sector is subject to strong industry dynamics. On the other hand, market entry barriers are comparatively low (Buxman et al. 2012). This leads to the need for incumbents, such as Google, to be continuously innovative. Therefore acqui- sitions serve as an external source of innovation. Thus, it is not surprising that this industry has become the leader in terms of the number of conducted mergers.1 The current situation of global tech mergers shows that the M&A volume is higher than in 2007. It is the highest first half-year volume since high-tech M&A peaked in 2000. Compared to the same period last year, the number of transactions jumped up by 13%.

illustration not visible in this excerpt

Figure 1-2 Global High-Tech M&A Volume - on a first half-year comparison

Source: Dealogic (Amaizo 2014)

Due to the relevance of acquisitions for high-tech firms in combination with increasing transaction volumes and prices the question of potential overpayment needs to be evaluated. The price Facebook paid for the acquisition of WhatsApp has been one of the most discussed investment themes of 2014 (Frier 2014). This price is more than 100 times higher than WhatsApp’s revenues in 2013 and even more than 200 times higher than the EBITDA (Edwards 2014). That leads to the question how this and other high prices and premia can be explained.

CEO Overconfidence

Earlier studies claim that expended market power and synergies are the main drivers of merger premium (Bradley et al. 1988). However, behavioural finance researchers have also identified the central role of CEOs in merger and acquisition decisionmaking (Roll 1986, Morck et al. 1990). Hence, this leads to the following question regarding the impact of CEO behaviour:

Do psychological biases affect the merger premium?

This question has led to a series of theories and analysis. Researchers have shown that apart from rational reasons behavioural factors have to be considered. The first studies concerning the question to which extent psychological biases affect decision-making suggested agency theory and information asymmetry as the main causes (Bitler et al. 2009, Jensen 1986). However, this explanation has been shown to be limited. More recent studies (Benartzi and Thaler 1995, De Bondt and Thaler 1985, Barberis et al. 1998) focussed on behavioural factors affecting the decision-making, especially the overconfidence bias. In 1986 Roll developed a theory which suggests the influence of CEO behaviour on merger activity. CEO self-confidence and optimism can have a great impact on CEO merger and acquisition behaviour.

Although the drivers of mergers and acquisitions have been extensively studied, few studies focus on the overconfidence of chief executive officers (Ferris et al. 2013). This dissertation complements the prior work developed within behavioural finance theories for merger activities.


Another - maybe even more interesting - issue can be deduced from figure 1-1: Face- book and Google - which conducted together 6 out of the 10 largest deals in the high- tech industry - are led by their founders Mark Zuckerberg (Facebook) and Larry Page (Google). This fact shows how important founder-CEOs have become for global business. Another example of the growing impact of founder-CEOs is that Google became the most valuable brand in May 2014 (Rooney 2014). The company overtook the leading position from Apple, a company which was also led to worldwide success by its founder Steve Jobs as the CEO.

The increasing influence of founder-CEOs can be explained through the changing CEO-policy. The classic start up model was it to have young founders starting a breakthrough company and then bring in experienced executives, once it was time to scale the business. In the last decade, however, that general rule has become modified - at least for many high-tech companies. Nowadays, founders remain CEO through the entire growth cycle of a company - examples are Larry Ellison, Steve Jobs or Mark Zuckerberg. The question is whether this change might be seen as a positive impact on the companies or if the founder as CEO is rather a burden for the firm.

The influence of founder on mergers and acquisitions in the high-tech industry and the shifting ‘founder-as-CEO policy’ in many firms make founder-CEO an interesting subject to study.

1.3. Rationale, Aims and Intended Contribution

Behavioural finance theories are relatively new and the amount of existing studies is limited. Therefore, examining the impact is essential to improve the understanding of financial merger activities. One of the major implications is based on overconfidence. De Bondt and Thaler (1994, p.6) argue that ‘perhaps the most robust finding in the psychology of judgment is that people are overconfident.’ However, the M&A litera- ture on overconfidence is focused on merger performance while relatively few studies discussed the merger premium, as expressed by John et al. (2010). The premium is not only a statement of pricing and the bidder’s expectation, but it also affects the ultimate merger performance. Schwert (2003) suggests that overpayment is the prime suspect behind the post-merger underperformance puzzle.2 A research gap is that most of the existing studies focus on the acquiring firm CEO, whereas there are always two par- ties involved: acquirer and target CEO (John et al. 2010). Moreover, researchers note that the high-tech industry and founder as CEO need to be studied in association with M&A. Due to a fact that the existing literature about high-tech M&A is rather small, Schief et al. (2013) suggest further studies. Barkema and Schijeven (2008) recom- mend studying the effects of CEO behaviour on the acquisition premium of dynamic markets, such as the high-tech industry. Abebe and Alvarado (2013) highlight the need to explore the impact of founder-CEOs on mergers and acquisitions. The combination of high-tech industry and founder-CEO is appropriate, as the industry includes a high percentage of founders who are or were CEOs.3

The objective of this study is to determine the effect of founder-CEO overconfidence on merger premium in the high-tech industry. Under consideration of the medial attention to founder-CEOs surprisingly few studies about founder-CEOs exist. Prominent founder-CEOs such as Steve Jobs, Mark Zuckerberg or Larry Page dominate the business press. To the best of the author’s knowledge, this is the first study which incorporates founder-CEOs and merger premium within the same study. Moreover, this dissertation aims to extend the existing literature about CEO overconfidence by exploring the potential impact when on the merger premium when both parties - acquirer and target CEO - are concurrently overconfident.

This paper can contribute to the research area by filling the mentioned gaps. Besides, this study can be seen as a useful contribution to the ongoing discussion about the suitability of founders as CEOs.4 In terms of professional life, this dissertation can contribute to shareholders’ or potential investors’ assessment of the CEO, as well as to potential target firms to assess the probability of CEOs paying a high premium. Another contribution is that this dissertation introduces a new overconfidence meas- ure, based on Ferris et al.’s (2013) findings about personal-related characteristics of overconfidence.

1.4. Outline of the Dissertation

The dissertation is structured as follows: Chapter two presents the relevant literature review on the research areas - merger premium, M&A in the high-tech industry, CEO overconfidence and founder-CEOs. The literature builds the basis for the research examined in this paper. Based on finance, strategic management and psychology liter- ature, research gaps are identified and presented in the section which reflects the liter- ature review, followed by the development of hypotheses. To empirically test the es- tablished hypotheses, chapter three presents the relevant data and the research method applied. That chapter first describes and justifies the dependent, independent and con- trol variables used in this paper. That chapter also describes the research sample and introduces the research method to evaluate the impact of overconfidence on merger premium. In chapter four the main results of the empirical analysis are presented, ana- lysed and discussed. Besides, robustness checks are conducted. Finally, the fifth chap- ter summarises the study and concludes the discussion, shows the contributions, fol- lowed by a discussion of the limitations and suggestions for further research.


2.1. Aim of the Chapter

The following chapter provides information of theoretical and empirical studies used as the basis of the study conducted in this dissertation. As the aim of this study is to examine the role of founder-CEO overconfidence on merger premium in the high-tech industry, this paper relates to such areas. First of all, section 2.2 provides reviews of merger premium and M&A in the high-tech industry. Section 2.3 presents CEO over- confidence and section 2.4 provides a review of founder-CEO characteristics. Section 2.5 reflects the literature review and lists the identified research gaps. Section 2.6 develops hypotheses on the basis of this review and the research gaps.

The aim of this chapter is to identify research gaps through a comprehensive review of relevant finance, psychology and management literature. The materials presented justify the study’s rationale and build the basis for the establishment of hypotheses, the identification of control variables and the discussion of the findings.

2.2. Merger Premium and M&A in the High-Tech Industry

Mergers and acquisitions are essential elements of strategic management which be- long to the most important activities of a company. A carefully structured acquisition can create substantial value by taking advantage of synergies. However, badly execut- ed or overpaid investments can also destroy value (Bell et al. 2013). M&A has been studied abundantly in the corresponding literature. However, in order to follow the research aims, the chapter focuses on a review of merger premium determinants and a review of M&A in the high-tech industry. The review of merger premium determi- nants discusses limitations of existing explanations for paid premia and differentiates the overconfidence theory from other theories.

2.2.1. Review of Merger Premium Determinants

Merger premium can be described as the difference between the estimated real value of a company and the actual price paid to acquire a company (Slusky and Caves 1991). Although there are no requirements to pay a premium above the fair price of a company, multiple potential reasons for paying premia exist. Previous studies show that merger premia may be determined by a complex variety of motives. The main explanations given in the literature are efficiency (synergies), misevaluation and agency problems. According to the efficiency theory, the main purpose of paying a merger premium is to achieve synergies. A synergy is achieved when the value of the new company is greater than the sum of two standalone companies (Jensen and Ruback 1983, Bradley et al. 1988). However, therefore the premium must reflect the value of the expected synergies to the acquiring firm. And although prior studies could relate merger premia to synergetic gains, the overall variance explained by this factor was small (Nielsen and Melicher 1973, Slusky and Caves 1991). Thus, syner- gies cannot adequately explain large merger premia.

Another motive is stock market valuation of companies. Stock market misevaluation creates opportunities to buy undervalued companies. Firms may also use their overvalued stock to acquire other companies, thereby locking in reals assets. Compared to overconfidence, the overvaluation hypothesis assumes that acquirers act rationally when exploiting market inefficiencies (Savor and Lu 2009).

As all theories are limited when explaining overpayment, finance researchers considered individual, group and social factors (Hirsch 1986, Haunschild 1994). Thus researchers detected other, less honourable reasons for acquisitions: Agency motivations. According to this theory, managers tend to maximise their own benefit (Black 1989, Shleifer and Vishny 1989). For example, managers tend to acquire to build an empire (Trautwein 1990). Empire building managers seek for more power and therefore often act against shareholder interests - in contrast to overconfident CEOs who truly believe in their abilities to create value.

Although the agency theory may help to explain the motivation for M&A to some extent, it is limited when explaining the fact that CEOs conduct value-destroying transactions with no personal benefits gained. One of the best examples is the unsuc- cessful merger of Time Warner and American Online in 2000. One year after the burst of the internet bubble, the management had to realise that growth assumptions were highly overstated.5 Interestingly, CEOs of both companies held stock options and ex- posures to the company’s stock performance. This leads to the assumption that agency problems were not an issue and overconfidence issues should be discussed instead.6 Therefore, further explanations, such as psychological factors need to be studied.

Literature of Drivers of Merger Premium

Based on the main explanations for merger premium paid, the extant literature identi- fies drivers that have an impact on the premium. The synergy’s hypothesis directly shows that related mergers generating higher synergetic advantages and thus a higher premium needs to be paid. Slusky and Caves (1991) suggest that acquirer pay higher premia in case of a particularly good fit between acquirer and target company. A sec- ond driver could also be identified in the merger premium determinants. Myers and Majluf’s (1984) suggest that if managers may know that their stock is overvalued, they want to convert these into real assets. In this point, Slusky and Caves (1991) ob- served that stock payment is positively related to acquisition premium.

Besides, researchers have identified that some firm and deal characteristics influence the premium. Some studies focus on the effect of firm characteristics. Hayward and Hambrick (1997) propose that the better the recent performance of the acquiring firm the higher is the premium paid. Moeller et al. (2004) suggest that the firm size has an impact on the premium. Their results show that large firms pay more for acquisitions. Haunschild (1994) proposes that the presence of competing bidders drives up the merger premium. Apart from firm characteristics, previous studies suggest the effect of deal characteristics. For example, Alexandridis et al. (2013) observe a negative relationship between offer premia and target size. The authors propose that the larger size of the target increases the complexity of the integrating process and thus leads acquirers to make lower acquisition offers.

These drivers provide useful control variables. Therefore, these drivers will be discussed in detail when discussing the control variables (chapter three).

2.2.2. Review of M&A in the High-Tech Industry

The main reason for acquisitions in the high-tech industry is to transfer and to inte- grate the acquired firm’s knowledge into the own company to create a substantial competitive advantage (Barney 1986). However, acquisitions may also have the aim for market-entry or the aim to expend the firm’s product range (Berkovitch and Narayanan 1993). A main issue of high-tech businesses is their enormous growth po- tential, which is often technology-based. However, for many businesses in this area growth potentials are highly uncertain. Thus, companies’ values are highly uncertain because they rely on uncertain future outcomes or developments. Considering this risk, potential acquiring CEOs are to be expected to have some degree of confidence in their ability to make a merger successful (Kohers and Kohers 2000).

Although high-tech mergers have received considerable media attention, the existing literature about high-tech M&A is rather small. Many studies have focused on tech- nical aspects (Leger and Quach 2009, Gao and Iyer 2006, Cloodt et al. 2006) while only a few studies focus on the effect of merger announcement performance and mar- ket reaction to merger announcements. Kohers and Kohers (2000) examine the post- merger performance of high-tech firms. Laamanen et al. (2014) report higher returns for acquisitions of divested assets.

2.3. CEO Overconfidence

Although the concept of overconfidence has been comprehensively researched in psy- chology and management literature, it got relatively low attention in finance research. This section first provides an introduction into the concept of overconfidence, fol- lowed by a literature review of studies of overconfidence and merger premium. Final- ly, the third section reviews measures for overconfidence used in prior studies.

2.3.1. Concept of Overconfidence

The impact of behavioural finance is discussed since psychological aspects of deci- sion-making questioned Fama’s (1970) Efficient Market Hypothesis. Behavioural finance attempts to explain how and why emotional, social and cognitive factors in- fluence individuals’ decision-making (Tversky and Kahneman 1974). The basic concept is that decision makers are prone to cognitive errors. Researchers observed that psychological biases - such as overconfidence, anchoring7 or framing8 - deviate people from acting purely rational.

One of the key psychological drivers is overconfidence. Langer (1975) defines over- confidence as the overestimation of one’s ability and of outcomes relating to one’s personal situation. Moore and Healy (2008, p.502) however observed that most em- pirical papers use the definition that ‘overconfidence is the overestimation of one’s actual ability, performance, level of control, or chance of success’. Empirical studies observed the overconfidence bias (e.g. Fischhoff et al. 1977, Weinstein 1980, Buehler et al. 1994). One vivid study was conducted by Kahneman and Riepe (1998). The authors’ study reports that 80% of the participants evaluated themselves as better drivers than the average.

The role of managerial overconfidence in firm decision-making is investigated in the corporate finance literature. Chatterjee and Hambrick (2007), for example, conduct a large sample empirical test on CEO overconfidence and its impact on firm strategy and performance. The authors came to the conclusion that overconfidence of leaders is often associated with risky decision-making.

Other studies examine the role of CEO overconfidence in a more specific context: M&A decision-making. In 1986, Roll suggested the influence of CEO behaviour on merger activities. Roll describes that managers of acquiring companies are affected by the hubris9 effect and thus pay higher premia. Based on the results of Roll (1986) aca- demics extended the research on overconfidence by studying the impact of overconfi- dence on manager’s decision-making and its effects on firm performance. Berkovitch and Narayanan (1993) empirically investigate Roll’s hubris hypothesis. Berkovitch and Narayanan (1993) observe that overconfidence drives merger and acquisition de- cisions. Brown and Sarna’s (2007) results support this finding. Gervais et al. (2003) conduct theoretical work to explore the impact of overconfidence on corporate in- vestment policy. Their study reports that overconfident CEOs are more likely to un- dertake risky projects than non-overconfident CEOs. March and Shapira (1987) argue that CEOs of acquiring companies have an illusion of control over the outcome of the combined company and underestimate the potential downside risk. In a well- documented work, Malmendier and Tate (2008) came to the conclusion that acquirer CEOs overestimate the value created by mergers as the managers believe that they can perform better than the current management. Moreover, the authors state that the managers overvalue the future returns of the company’s project. Malmendier and Tate (2005a) explore that overconfidence can be a driver for merger decisions. Rovenpor (1993) conducts a psychology study to examine the relationship between CEO per- sonality characteristics and M&A activities. The author observes that managers who overestimate their own skills also overestimate the value of potential mergers. Doukas and Petmezas (2007) believe that CEO overconfidence results from a self-attribution bias. According to the authors, this bias encourages CEOs to engage in highly com- plex transactions.

2.3.2. Review of Overconfidence and Merger Premium

The literature of overconfidence and M&A shows that very few studies focus on merger premium.

Hayward and Hambrick (1997) use a sample of 106 large acquisitions of 1989 and 1992 to examine acquirer CEO overconfidence and the size of merger premia paid. The authors find that four indicators are highly associated with premium paid: (1) the acquiring company’s recent performance, (2) recent media praise, (3) CEO’s self- importance and (4) a composite factor of these three variables. Aktas et al. (2010), using a sample of 146 US mergers, find a positive impact of target CEO narcissism on merger premium. The authors use the prevalence of personal pronouns in CEO speeches to classify a CEO as narcissistic. John et al. (2010) take acquirer and target CEO overconfidence into account to examine the impact on merger premium. The authors use Holder67, as well as Media Portrayal 10 as proxies for overconfidence. John et al. (2010), utilizing a sample of 1,888 M&A deals, not only find a positive impact of CEO overconfidence on the premium paid, but also suggest that combined acquirer and target CEO overconfidence causes the highest overpayment. Levi et al. (2013) investigate the effect of female board directors on merger premium. The authors show that female directors are less overconfident than male directors and thus firms with female directors pay lower merger premia in their study of 458 deals of US public acquiring and public target companies (1997-2009).11

The following table provides an overview of the studies:

Table 2-1

Literature Overview regarding CEO Overconfidence and Merger Premium

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2.3.3. Review of Overconfidence Measures

Overconfidence is - similar to other psychological factors - difficult to operationalise. In order to study the impact of this psychological determinant proxies have to be found. The proxy can be considered as the most crucial aspect when studying the ef- fects of overconfidence. This section provides an overview about proxies identified in previous studies.

Literature about finance and psychology literature mention direct and indirect meas- ure of CEO overconfidence. Malmendier and Tate (2005a) develop three different measures of overconfidence: Holder67, Longholder and Netbuyer. The first measure, Holder67, assumes that CEOs who do not exercise in-the-money stock options are likely to be overconfident, because they think that their superior leadership will lead to a continually rising stock price. A CEO is classified as overconfident if he holds options that are more than 67% in-the-money. Malmendier and Tate (2008) demon- strate that alternative potential reasons for such behaviour (keeping the stock options), such as inside information, signalling, board pressure, risk tolerance and taxes do not explain the fact that CEOs do not exercise in-the-money stock options. The second proxy suggested by Malmendier and Tate (2005a), Longholder, is built on the same explanation. It categorises a CEO as overconfident if he holds any in-the-money op- tion until expiration, even though the option is at least 40% in-the-money, entering its final year. The third measure, Netbuyer, considers additional shares bought by the CEO on the market. In a related paper Malmendier and Tate (2005b) suggest press portrayal as another measure. This proxy describes the characterisation of the CEO made by the public. Thus, this measure relies on exterior perception rather than on the CEO’s own actions. As mentioned before, Hayward and Hambrick (1997) propose four indicators as proxies for CEO overconfidence: (1) the acquiring company’s re- cent performance, (2) recent media praise, (3) CEO’s self-importance and (4) a com- posite factor of these three variables. The authors note that recent success makes the CEO more confident in his ability to create value through acquisition and thus would like to pay a higher premium. Second, they suggest that recent media praise conveys an external validation about the CEO’s abilities to the CEO. Third, their results sug- gest that premium and self-importance - measured by the CEO’s payment relative to the payment of the second-highest-paid executive - are associated. Doukas and Pet- mezas (2007) propose that the decision of managers to be highly active in acquisitions can be seen as a proxy for overconfidence. The authors classify CEOs as overconfi- dent, when five or more acquisitions within a short period of time (three years) are made. They argue that making so many acquisitions within a short period of time can- not sufficiently evaluate synergies and make negotiation efficiently. Brown and Sarna (2007) add ‘CEO dominance’ to the list of proxies. The authors include this variable as it shows if a CEO has the power to exercise corporate decisions. Aktas et al. (2010) measure narcissism by the prevalence of personal pronouns used in CEO speeches. Kolasinski and Li (2013) suggest an ex-post measure of overconfidence. CEOs who lose money with private investments in their own firm are classified as overconfident since they have overestimated the value of the firm. Some previous studies used psy- chologically based tests to measure overconfidence. Ben-David et al. (2013) used managers’ expected stock market returns for the next year and for the next 10 years. Trevelyan (2008) uses life orientation test (LOT), introduced by Scheier et al. (1994).

The LOT is a scale that evaluates the extent to which individuals have positive expec- tations.

The following table provides a brief overview of existing overconfidence measures:

Table 2-2

Overconfidence Measures


Year of

Overconfidence measure

financial proxies

Malmendier and Tate Malmendier and Tate

Hayward andHambrick

Doukas and Petmezas Brown and Sarna

Aktas et al.

Kolasinski and Li

psychology measures

Ben-David, Graham and Harvey Trevelyan

2005a Holder67, Longholder, NetBuyer 2005b Media Portrayal

(1) Acquirers recent performance, (2) recent media praise 1997 for the CEO, (3) CEO self-importance, (4) composite factor

of these three variables 2007 Merger activity

2007 CEO Dominance

2010 Prevalence of personal pronounces used in CEO speeches

2012 Own firm investment

2013 Miscalibration

2008 Life orientation test (LOT)


However, existing proxies have been subject to criticism. Moore and Healy (2008) criticise existing measures as the measures provide inconsistent findings. These in- consistent findings might be caused by disadvantages of existing measures. One drawback of Holder67, Longholder and Netbuyer might be that there are some alter- native explanations for holding stock options (Doukas and Petmezas 2007). CEOs may hold in-the-money stock options not because they are overconfident, but because of inside information. Another potential explanation is that CEOs want to send posi- tive signals to the market through holding in-the-money options. CEOs behaviour could also be related to the firm’s past performance. Strong recent performance may lead CEOs to expect that the firm will continue to perform strongly in the future.

Further Indicators for Overconfidence

In two recent studies, Ferris et al. (2013) and Levi et al. (2013) suggest further indicators for overconfidence. Ferris et al. (2013) propose that national, religious and cultural characteristics can indicate overconfidence. The authors have shown that the following characteristics have a significant influence on overconfidence: (1) Countries with common law, (2) Christianity, (3) Language (4) Individualism, (5) Uncertainty Avoidance, (6) Long-term orientation.12 Levi et al. (2013) suggest that men and women are different in their tendency to be overconfident. The authors describe that female directors are less overconfident than male directors.

As this dissertation builds on Ferris et al.’s (2013) and Levi et al.’s (2013) results, the national, religious, cultural and gender characteristics are explained in detail in chap- ter three.

2.4. Review of Founder-CEO Characteristics

Compared to manager-CEOs, founder-CEOs show a series of different characteristics. Previous studies have generally explored psychological and personal differences (McClelland 1965, Brockhaus 1980, Adams et al. 2009, Fama and Jensen 1983). Four main differences can be named: Total commitment to the long term, moral authority, comprehensive knowledge and decision-making power. Founder-CEOs consider their company as their life’s achievement, thus, the intrinsic motivation and the personal commitment to the firm is higher. Founders are deeply involved in the firm’s culture and firm’s strategy (Baron et al. 1999). Due to the high commitment, personal and the firm’s aims are similar. That fact can potentially reduce the principle-agent problem (Fahlenbrach 2009). Fama and Jensen (1983) also believe that the extraordinary commitment reduces the drain of organisational resources. Founder-CEOs serve as a symbolic leader for the firm (Bamford et al. 2006). They provide a high level of tech- nical and market expertise as well as good firm-specific knowledge (Fama and Jensen 1983). Founders often hold large absolute or relative stakes (Ling et al. 2007). Thus, founders have a greater power and influence within the organisation than manager- CEOs.

Researchers observed that firms with a founder as CEO have different firm valuation, investment behaviour and stock market performance. Firms with a founder-CEO tend to invest more in research and development, have higher capital expenditures and make more mergers and acquisitions (Fahlenbrach 2009). Recent studies show that companies with their founders as CEO have higher valuations than other companies with managers-CEOs (Adams et al. 2009, Anderson and Reeb 2003, Villalonga and Amit 2006). Due to higher intrinsic motivation founder-CEOs follow a long-term ap- proach. Another group of studies identifies stock market differences. Fahlenbrach (2009) studies the stock market performance of 361 large and publicly traded firms from 1993 to 2002 and observes a positive relationship between founder-CEOs and stock market returns. This result is supported by Adams et al. (2009), Abebe and Al- varado (2013) and He (2008). Besides, He’s (2008) results also show that founder- managed firms are more likely to survive than professional managed firms.

There are a few numbers of studies which discuss the reasons of performance and the influence differences between founder-CEOs and non-founder counterparts. One ex- planation is based on entrepreneurship. This theory assumes that a founder-CEO of- fers a higher level of passion and vision and that entrepreneurs may have a greater risk-takers propensity (Brockhaus 1980). Second, the resource-based theory suggest that there is a significant negative relationship between founder-CEO and firm per- formance. This explanation argues that founder-CEOs miss essential managerial skills and thus can be a liability to the firm (Boeker and Karichalil 2002). Wasserman (2012) specifically discuss the lack of managerial skills in high-tech start-up firms. Willard et al. (1992) argue that founders are interested in the development of a prod- uct whereas they have very limited managerial interests. For general management tasks founders neither have appropriate knowledge nor natural inclination. The organ- isational life cycle theory supposes that management skills are required during various phases of the evolution of a firm. That implies that new ventures reach a stage of de- velopment where founder skills are no longer sufficient to lead a company effectively (Certo et al. 2001). Hence, the natural process requires the replacement of founders by professional managers (Rubenson and Gupta 1992).

Some studies discuss the effect from a behavioural perspective. However, arguments are mixed. Busenitz and Barney (1997) point out that entrepreneurs are more suscep- tible to decision-making biases, such as overconfidence. They assume that these bias- es are beneficial for many entrepreneurial decisions, such as implementing a venture or persuading others to invest into the venture. The authors argue that under uncertain and complex conditions, biases and heuristics can be an effective and efficient guide to decision-making, because cautious decision-making is not possible. However, the authors also admit that cognitive biases can under some circumstances lead to major errors. Ranft and O’Neil (2001) also point out the tendency of founder-CEOs to be narcissistic. The authors think that this bias has a negative effect on the firm perfor- mance. They argue that overconfident leaders isolate themselves from the advice of others and that overconfident CEOs only listen to the information they seek. Haley and Stumpf (1989) assume that non-rational decision-making may explain significant variations in investment decision-making.

Considering these arguments, it can be expected that there are positive as well as negative founder-CEO effects. This study investigates to which extent founder-CEOs have positive or negative effects on merger decision-making.

2.5. Reflection on the Literature Review

Through reviewing the literature, it has become obvious that merger premium is an important factor that has not been comprehensively studied in relation with CEO overconfidence. It has been detected that most studies mainly focus on the effects of CEO overconfidence in acquiring firms, while missing to take any parallel bias among target firm CEOs into account. Moreover, deal and firm characteristics are identified that may have an impact on merger premium paid, such as method of payment, rela- tive size, merger competition, Tobin Q, relatedness and firm size. Besides, it has been identified that the high-tech industry plays an important role in mergers and acquisi- tions. The overview has shown that founder-CEO has not been subject to existing studies of overconfidence and merger premium. However, considering the importance role of high-tech companies and founder-CEOs it is surprising that both have not been subject to distinct studies about M&A and overconfidence.


1 Regarding the transaction volume the industry is second and sixth place in the USA and Europe, respectively (Buxman et al. 2012).

2 See also Morck et al. 1990, Shleifer and Vishny (1989), Hayward and Hambrick (1997).

3 Amongst the most known are: Stan Shih (Acer), John Warnock (Adobe), Jeff Bezos (Amazon), Jerry Sanders (AMD), Steve Jobs (Apple), Ken Olsen (DEC), Michael Dell (Dell), Scott Cook (Intuit), Bill Gates (Microsoft), Larry Ellison (Oracle), Dave Duffield (Peoplesoft), Mark Benioff (, Diane Green (VMWare)

4 See: Griswold (2014), Horowitz (2010).

5 In January 2010 the responsible CEO Gerald Levin called the merger the ‘worst deal of the century’ Ostrow, A. (2010).

6 In the case of AOL and Time Warner, this fact was confirmed indirectly nine years after the announcement of the merger when the merger was undone in 2009 with the spin-off of AOL.

7 Tversky and Kahneman (1974) observed that individuals tend to set a reference point and make estimations around that ‘anchor’.

8 Tversky and Kahneman (1981) demonstrate that human decisions depend on the fact whether something is expressed either in a positive or negative manner.

9 Bollaert and Petit (2009) point out that the term hubris which is not precisely defined is often understood as overconfidence.

10 The overconfidence measures will be explained in the next section.

11 The main objective of this study is to analyse the effect of CEO overconfidence on merger premium. However, board director and merger premium is also incorporated (in chapter 4).

12 Individualism, Uncertainty Avoidance and Long-term orientation are based on Hofstede’s (2001) cultural dimensions.

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The Effect of Founder-CEO Overconfidence on Merger Premium
Heriot-Watt University Edinburgh  (Finance)
Corporate Finance
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ISBN (eBook)
ISBN (Book)
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Mergers and acquisitions, Behavioral finance, Investment management, High-tech industry, Corporate Governance, Media Portrayal, Principle Component Analysis, Holder67, merger activity, CEO dominance, Tobin Q, relative size
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Christoph Meyer (Author), 2014, The Effect of Founder-CEO Overconfidence on Merger Premium, Munich, GRIN Verlag,


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